Unfunded Defined Benefit Schemes

[Phani Vasantarao]

Why do we say that defined benefit schemes may be funded or unfunded, when there is a regulatory requirement to maintain a certain funding level? How exactly would an unfunded DB scheme work?

 

[mugono]

Why do we say that defined benefit schemes may be funded or unfunded, when there is a regulatory requirement to maintain a certain funding level? How exactly would an unfunded DB scheme work?

An unfunded pension scheme pays members out of current revenue streams (assets aren't built up over time to meet the scheme's liabilities). One example of this are state benefits where a government pays state pensions out of current tax receipts.

To my knowledge, there is no regulatory requirement for pension schemes to maintain a certain funding level - certainly not to the same extent that insurers are required to maintain solvency, e.g. Solvency II in the UK / EU (provided that the sponsor is a going concern).

A funded pension scheme in deficit (i.e. where assets are set aside to meet current / future liabilities) may be required to put in place a deficit reduction (or funding) plan to eliminate the scheme deficit within a defined period of time.

 

[Lindsay Smitherman]

Great answer. Just to add, in CP1 terminology an unfunded pension scheme operates on a 'pay-as-you-go' basis: money is found to pay the benefits when the benefit falls due and this money is not set aside in advance. Also remember that CP1 is not jurisdiction specific, so try not to assume that certain regulation/legislation must be in place.

 

[Phani Vasantarao]

Thank you both, that makes it very clear!